If you are happily entrenched working with high net-worth clients and think what’s going on in the middle market is of little concern to you, you may be doing so at your own eventual peril. Hear me out for a minute.
We all know life insurance products have enjoyed tax-free death benefits and a tax exclusion for investment income of life insurance products (inside buildup) for a century, which has always added to the appeal of life insurance in the minds of consumers. In the past century, these tax advantages have been challenged and debated by the federal government at least a dozen times. Every time, “cooler heads” have prevailed to preserve this favored treatment because they have recognized the important benefit to society of people being covered by life insurance.
But just because it’s always survived these challenges in the past does not mean it will survive the next serious challenge — which could very well come in 2013.
With an ever-growing $16 trillion national debt, comprehensive tax reform will be a top priority for Congress in 2013. Everything — including the tax-favored status of life insurance — will be back on the table. Industry associations such as AALU and NAIFA are gearing up to once again defend the virtues of life insurance’s tax advantages and warn Congress of the unintended consequences the elimination of these tax benefits would create.
But lawmakers will be forced to make many difficult choices, and there is fear that some on Capitol Hill are becoming less sympathetic to the industry. The reason for this is that the perception of life insurance as protection for widows and orphans is gradually changing, in the minds of some, to a perception that life insurance has become a tax shelter for the rich.
Why is this perception out there? Perhaps because most producers in the independent life insurance distribution channel naturally tend to migrate toward the affluent market as they grow their practice and become more experienced.
See also: Why we chose the middle market
You can’t blame producers for that, but it does tend to leave the middle market uncovered, if you will. If the middle market is not being adequately served — and we know from study after study that the Average Joe is rarely contacted by a producer about life insurance — then you risk losing that “protecting widows and orphans” street cred. As Charlie Smith, ChFC, CLU, AEP, former president and CEO of GAMA International, told The Wall Street Journal back in an Oct. 3, 2010, article, “If the industry no longer has a significant presence on Main Street, it loses its political clout in Congress and can’t defend the tax benefits.”
Perhaps you’ve heard of the Shelf Project, an effort by academics in the tax community to develop “well thought-out” tax proposals that Congress can consider to raise revenue. Congress can save time by taking these proposals “off the shelf” when the need arises to raise revenue. One such proposal currently on the shelf would tax the earnings on life insurance contracts, viewing the cash value as an investment, not a prepayment of future mortality costs.
The Center for American Progress, an independent, nonpartisan educational institute based in Washington, D.C., estimated in a 2011 “Tax Expenditure of the Week” release that the inside buildup tax subsidy for life insurance is expected to cost the federal government $129 billion between 2012 and 2016. This is just the kind of tax “loophole” many lawmakers will be looking to close in an effort to reduce the deficit. The need to generate additional revenue will drive tax reform efforts every bit as much as reducing spending, and $129 billion over the next few years might look pretty attractive — especially if it is looked at as closing a loophole for the wealthy.
If the inside buildup of cash value policies were to be taxed, you quite suddenly have a lot of affluent clients losing interest in permanent life insurance, soon followed by fewer advisors selling permanent life insurance.
The industry’s upcoming lobbying efforts may very well once again prevent Congress from making any changes to the tax status of life insurance products. But any producer who values the future of his business model ought to be involved with AALU and/or NAIFA’s efforts to educate lawmakers and their staffs with their wallet and their voice.
For a closer look at the issue, please read Part IV of Life Insurance Selling’s series, “The Fight for Independents,” which focuses on the dangers of ignoring the middle market.
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